How liquid funds are taxed?

funds are taxed

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Debt mutual funds are one of the popular investment options in India. A reason behind the popularity of debt mutual fund investment is its less risky nature, unlike equity investments. However, before investing in a debt fund, select the mutual fund type that suits you the most. One of the variants of debt mutual funds is liquid funds.

What are liquid funds?

Liquid mutual funds allocate funds to fixed-income instruments. Some examples of fixed-income securities are government securities, treasury bills, and commercial papers. The maturity of these securities might go up to 91 days. Additionally, your withdrawals might get processed within 24 hours. Liquid fund investment is known for having the lowest interest-rate risk in debt funds.

How do liquid funds work?

Liquid fund aims to provide capital protection and liquidity to its investors. The fund manager chooses high-quality debt securities and allocates funds as mandated. Before allocating funds, the manager ensures that the average maturity is not more than 91 days. Shorter maturity ensures that the fund is less susceptible tochanges in interest rates. The fund manager tries to deliver returns by trying to match the maturity of individual securities with that of the portfolio.

What are the advantages of liquid funds?

Liquid mutual funds come with numerous advantages. Some of them are:

They have lower risks

The debt instrumentsliquid funds usually invest in, come with a short maturity period, i.e., less than 91 days. Short maturity means that the default risk is low.You must also note that the NAV of liquid funds rarelyfluctuatesbecause of low volatility.

They offer higher returns

A liquid fund investment can giveyou a 7% to 9% return. In fact, some believe that liquid funds offer better returns than other investment options.

Exposure to the fixed-income market

In the past, only banks, insurance companies, and pension funds had a monopoly over the fixed-income market.However, liquid funds changed everything.Retail investors nowadaysallocate funds to the Indian fixed-income market through these funds.

Liquid funds are affordable

An attractive feature of liquid mutual funds is that they are inexpensive. For example, FDs may require a minimum investment amount of ₹5000. However,  you can start a SIP for liquid funds at just ₹500. You can also opt for the lump sum option of just ₹1000.

Suitable for senior citizens

Senior citizens generallyallocate funds to Senior Citizens Saving Scheme or fixed deposits. However, these schemes usually have a minimum lock-in period. On the other hand, liquid funds don’t have a lock-in period, making them a reliable option for senior citizens.

How are liquid funds taxed?

You can enjoy both capital gains and dividends by investing in liquid funds. You don’t need to pay any taxes for dividends. However, taxes are applicable for both long-term capital gains and short-term capital gains. Let’s look at these two scenarios:

  • If you sell the units of your liquid fund scheme within 3 years, your returns will be eligible for short-term capital gain taxes. In such cases, the returns are considered income and you must pay taxes based on your income tax slab rate.
  • If you sell the units after holding onto them for over 3 years, the returns will be considered long-term capital gains. However, in this situation, you can also enjoy an indexation benefit. The capital gains in this circumstance will be taxed at a flat rate of 20%

Conclusion

Liquid funds are a flexible investment option that doesn’t cost that much. It is convenient to invest in them because a liquid fund investment is not that heavy on the wallet. You can opt for the SIP route and invest in it regularly. But determine the investment amount first. To do so, use the online SIP calculator.

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